Will You Owe the 3.8 Percent Medicare Tax on Investment Income?
Beginning in 2013, a new Medicare tax may apply to your dividend and interest income. Under the Affordable Health Care Act, taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for joint filers and $125,000 for married filing separately) may owe a new Medicare contribution tax, also referred to as the “net investment income tax” (NIIT). The tax equals 3.8 percent of the lesser of your net investment income or the amount by which your MAGI exceeds the threshold.
Only individuals with some amount of net investment income and MAGI above the applicable threshold amount will be subject to the 3.8 percent NIIT. For example, if a married couple has $200,000 of wage income and $100,000 of interest and dividend income (i.e., MAGI totaling $300,000), the 3.8 percent NIIT applies to the $50,000 that is over the $250,000 MAGI threshold.
Trusts and estates may also be hit with the 3.8 percent NIIT. But for them, the tax applies to the lesser of their undistributed net investment income or AGI in excess of the threshold for the top trust federal income tax bracket. For 2013, that threshold is only $11,950, so many trusts and estates will likely be affected.
The components of net investment income generally include gross income from interest, dividends, royalties and rents; gross income from a trade or business involving passive activities; and net gain from the disposition of property (other than property held in a trade or business in which the owner materially participates). All of these components are reduced by any allocable deductions.
The rules on what is or isn’t included in net investment incomer are somewhat complex, so consult your Whalen tax adviser for additional information.
Finally, many of the strategies that can help you save or defer income tax on your investments can also help you avoid or defer NIIT liability. Because the threshold for the NIIT is based on MAGI, strategies that reduce your MAGI, such as making retirement plan contributions, can also help you avoid or reduce NIIT.
Please contact your tax adviser to discuss the 3.8 percent NIIT or any other tax compliance or planning issue.